Computational Finance

Chapter 11 – Three Hundred Years of Stock Market Manipulations

300 Years of Stock Market Manipulations – From the Coffeehouse to the World Wide Web’s Stock Manipulations

In previous chapters, we saw that many of the changes in securities markets brought about by information technology in general and the Internet in particular are positive, democratizing access to markets and information. We also saw that technology is not always an unadulterated boon, and there is ample opportunity to fool yourself by blind data mining, and to find people trying to fool you using an ever-expanding bag of tricks, cons, and manipulations.

As information technology has expanded the scope of resources available to legitimate investors and traders, the Web has also become the prime new venue for the old game of market manipulation. Institutional traders and other long-term market participants often comment that they see far more inexplicable price moves than they did in the pre-Web era. In many cases, these moves are tied to subtle, and not so subtle, attempts at market manipulation using the newfound power of the Internet to transmit and spread rumors, manipulate beliefs, and post incorrect information at little cost, while maintaining the cloak of anonymity.

Price distortions arising from manipulations may be short-lived, but they are real prices, and can dramatically affect the cost of trading and investment performance. The influence of the rumor machine is overlaid on the influences of more fundamental (and benign) factors that move stock prices. Therefore, interest in manipulations is not confined to the most obvious potential victims, specialists, dealers, and market makers but to all buy-side traders. This chapter examines the nature and characteristics of Internet market manipulations and their non-electronic precedents, going back 300 years.

The Real Economic Impact of Pump and Dump Stock Market Manipulations

In 1999, NEI Webworld, Inc. (NEIP) was an obscure, nearly bankrupt printing company. Its stock barely had a pulse. It had been kept alive as a shell company, used by firms that wanted to access the public markets, but without the scrutiny that comes with an initial public offering (IPO). The last trade had been over a year earlier, for a penny and a half.

Suddenly it rocketed up 106,600 percent in one morning. What happened? A miracle cure? A hit movie? Pokémon lunch boxes? No, none of these. NEIP’s move was propelled purely by the power of Internet message boards. Two (subsequently indicted) UCLA students dramatically demonstrated how the new technology of the Internet had dramatically transformed the old game of market manipulation.

The Internet raises market manipulation to a level only dreamed of by past shysters. It used to take a real effort, a PR firm, or a major newspaper column to reach millions of potential traders. Now anyone can do it from their desktop. The Internet era is defined by the unparalleled ability of the new style of manipulator to use the Internet to affect the perceptions of vast numbers of investors at lightning speed, all the while remaining completely anonymous. This article looks at market manipulations — from early scams of the 1600s to the high-tech frauds of today — and asks how the game has changed and what you can do to protect yourself.(1)

Who cares about this, anyway? Aren’t these just isolated instances of little concern to ordinary investors? Absolutely not! There are hundreds of well-documented cases involving message manipulation, with financial impacts running into the billions of dollars. And it’s not just micro-cap stocks; recently multibillion-dollar Lucent Technologies was the subject of a successful manipulation attempt. When the people who get burned complain to the authorities, the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), New York Stock Exchange (NYSE), and National Association of Securities Dealers (NASD), all examine messages in their investigations.

The SEC set up an office back in 2000 just to deal with Internet scammers. These agencies are reactive — the investigators head for the message boards after someone complains that something suspicious has occurred in a stock.

Brokers, market makers, specialists, and traders, however, care in a proactive sense. They want early warnings of potential trouble ahead so they don’t get left holding the proverbial bag. The Web has become the new prime venue for the old game of market manipulation. But it is not just the most obvious potential victims — specialists, dealers, and market makers — who care about manipulations. All good buy-side traders care about manipulations. If you have an order to trade in size — say, one day’s average daily volume — you may be planning to execute the trade in parcels over three days. Price distortions arising from manipulations may be short-lived, but they are real prices, and can dramatically affect the cost of trading(2) and investment performance. The influence of the rumor machine is overlaid on the influences of more fundamental (and benign) factors that move stock prices. In an extreme case like NEIP, there are no other factors, but there are few if any stocks that are immune from these effects.

A Classic Market Manipulation – A Long History of Investment Manipulation

The ignoble history of stock market manipulations doubtless goes back to the most ancient markets. In one of the earliest accounts of manipulations, Joseph de la Vega, in Confusión de Confusiones , wrote of the Amsterdam Stock Exchange over 300 years ago (1688): The greatest comedy is played at the Exchange. There, . . . the speculators excel in tricks, they do business and find excuses wherein hiding places, concealment of facts, quarrels, provocations, mockery, idle talk, violent desires, collusion, artful deceptions, betrayals, cheatings, and even tragic end are to be found.(3)

In the Amsterdam market at the time, market manipulations were common. De la Vega provides a comprehensive model of the various manipulations used to trick unsuspecting investors, including early versions of such perennial favorites as “painting the tape” * , making small trades to move the price. De la Vega’s book, Confusión de Confusiones , was picked by the Financial Times as one of the 10 best investment books ever written.(4) [Painting the tape is the illegal practice in which traders buy and sell a specific security among themselves, in order to create an illusion of high trading volume. Traders profit when unsuspecting investors, lured in by the unusual market volume, buy the stock.]

In the Amsterdam market of the late 1600s, there were two active stocks — the Dutch East India Company and the Dutch West India Company — and most of the activity revolved around speculation about the cargoes of the ships of these companies entering the port. One of the most successful stratagems was the spreading of false rumors in Amsterdam coffeehouses ( coffy huysen in Dutch) frequented by traders and brokers. As de la Vega describes it: “The bulls spread a thousand rumors about the stocks, of which one would be enough to force up the prices.”(5) Manipulators would falsely bid up the prices of stocks through a variety of artifices, including painting the tape and the spreading of overly optimistic news. Brokers would hint that ships soon to enter port carried rich cargoes ( “No tea and spices — they’ve got furs and diamonds” ), and soon the rumors would get ever more extravagant ( “Lots of furs and really big diamonds” ), leading to large price run-ups. Some things in life are fairly constant.

The Very Model of a Modern Market Manipulator on Stock Market Message Boards

There is no de la Vega for the twenty-first century, but there is Tel212, an anonymous poster to Yahoo!’s message boards.(6) The remarkable message that follows contains much of the same material, updated for the Internet, 320 years later. …

All notes for this chapter about Stock Market Message Boards, Stock Recommendations, and Pump and Dump Stock Manipulations on Internet Social Media:

This article originally appeared in the Summer 2001 issue of the Journal of Investing. It is reprinted in Nerds on Wall Street with permission. To view the original article, please go to iijoi.com. My coauthor, Ananth Madhavan, was at the University of Southern California when we started this, was at Investment Technology Group (ITG) when we finished, and is now director of trading research at Barclays Global Investors.

1. Corners and short squeezes, including various railroad manipulations by Cornelius Vanderbilt and others at the turn of the twentieth century, represent another form of manipulation through scarcity as opposed to redirecting people’s beliefs. This chapter focuses on manipulations based on false information of one type or another.

2. The real cost of trading is the difference between the price at the time you decide to trade and the total price at the time you actually trade. Commissions are usually the smallest part of this. Market impact and the opportunity cost of delay far outweigh the commissions. See the discussion in Chapter 5.

4. Confusión de Confusiones and Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (another of the FT editors’ top 10) are published together in the Wiley Investment Classics Series.

5. De la Vega, Confusión de Confusiones , p. 203.

6. The URL at the time the article was written was http://messages.yahoo.com/bbs? action=m & board=18185330 & tid=wgat & sid=18185330 & mid=16909 . However, this guide seems to have wisely been removed.

12. This was written in 2001, and the prediction has proven correct. The entire genre of so-called pictograms — pictures of text touting a stock in spam e-mail — rose to a minor industry, and vanished as better anti-spam measures took hold.

Wall Street Analytics

More Praise for “Nerds on Wall Street” ("New technologies are exploited first by "alpha geeks," folks with the skills to push the envelope. This is as true on Wall Street as it was on the web. Leinweber was one of those alpha geeks, but is also the first to chronicle the innovation process from early adopter to mainstream acceptance."
Tim O’Reilly
Founder & CEO, [...])

Part 4 – Nerds Gone Wild – Wired Markets in Distress (Financial Nerds Gone Wild - Global Markets in Distress
The original plan for this book stopped after the three parts that you’ve just read. These parts are about how markets became machines, and about using more machines to pick stocks and trade them electronically, bringing in an assortment of nifty ideas from finance and computer science [...])

Part 3 – Artificial Intelligence and Intelligence Amplification (Artificial Intelligence and Intelligence Amplification in Financial Markets
Securities Markets are Machinery Now.
This raises the question of how to best participate in the world’s new wired markets. People who use information technology most effectively will be rewarded.
Artificial intelligence (AI) as an academic discipline began at the famous 1955 Dartmouth conference organized by John McCarthy from Stanford [...])

Chapter 12 – Shooting the Moon – Stupid Financial Technology Tricks (Stupid Financial Technology Tricks and Global Economic Collapse
Like many others from the stock side of greater Wall Street, I felt blindsided by the events of 2008. “Blindsided” is actually a gross understatement; I felt like the guy who comes home and finds the neighbors were running a meth lab that has exploded and flattened the [...])

Chapter 08 – Perils and Promise of Evolutionary Computation on Wall Street (Using Genetic Algorithms, Optimization Models, and Evolutionary Computation on Wall Street
“Be careful what you ask for — you might get it.”
My enthusiasm for machine learning, described at the end of the previous chapter, led me to kiss many artificial intelligence ( AI ) frogs. This included many flavors of inductive and explanation - based learning, [...])

Chapter 10 – Collective Intelligence, Social Media, and Web Market Monitors (Web Market Monitors and the Impact of Social Media on Financial Markets
"The words of the prophets are written on the subway walls." — Simon & Garfunkel, The Sound of Silence
Opinions vary widely on the value of collective wisdom, with ample supporting evidence both for and against. The Internet has many positive examples: The collective ratings [...])

Chapter 02 – Greatest Hits of Computation in Finance (Computational Finance, Stock Market Analysis, and Investment Trading
"A computer does not substitute for judgment any more than a pencil substitutes for literacy. But writing without a pencil is no particular advantage." - Robert McNamara
The Journal of Portfolio Management (JPM*) is one of the more upscale investment management publications around. For $500 a year, you get [...])

Forward by Ted Aronson (Nerds on Wall Street Forward by Ted Aronson
Quantitative finance is not a topic usually associated with laughter. That is about to change with the publication of Nerds on Wall Street.
I was first exposed to Dave Leinweber’s wit when he delivered a speech entitled “Nerds on Wall Street.” I believe the event happened 20 or 25 [...])

Alpha as Life
(Passive Investing - Active Investing - Alpha Returns
Index funds are passive investments; their goal is to deliver a return
that matches a benchmark index. The Old Testament of indexing is Burton
Malkiel’s classic A Random Walk Down Wall Street, first published in
1973 by W.W. Norton and now in its ninth edition. For typical
individual [...])

Wired Markets (
Financial Markets - Electronic Markets
Not too long ago, going to a stock market meant you would meet lots of
new people who were energetically shouting, running around, and making
a mess with great quantities of paper. No more. Visiting a financial
market now is more like visiting a telephone exchange. It can be a wild
ride versus parking your cash in a few money market funds. Computers
and
network gear [...])

Nerds
Gone Wild – Wired Markets in Distress (Financial Nerds Gone
Wild - Global Markets in Distress
The original plan for this book stopped after the three parts that
you’ve just read. These parts are about how markets became machines,
and about using more machines to pick stocks and trade them
electronically, bringing in an assortment of nifty ideas from finance
and computer science [...])

A
Little Artificial Intelligence Goes a Long Way on Wall Street
(A Little AI Goes a Long Way on Wall Street: Artificial Intelligence
and Securities Trading
“If you give someone a program, you will frustrate them for a day; if
you teach them how to program, you will frustrate them for a lifetime.”
This is a history and technical overview of one of the earliest
artificial intelligence re (AI), and is a far cry from simple financial
planning software [...])

Collective
Intelligence, Social Media, and Web Market Monitors (Web
Market Monitors and the Impact of Social Media on Financial Markets
"The words of the prophets are written on the subway walls." — Simon
& Garfunkel, The Sound of Silence
Opinions vary widely on the value of collective wisdom, with ample
supporting evidence both for and against. The Internet has many
positive examples: The collective ratings [...])

Artificial
Intelligence and Intelligence Amplification (Artificial
Intelligence and Intelligence Amplification in Financial Markets
Securities Markets are Machinery Now.
This raises the question of how to best participate in the world’s new
wired markets, and this is anything but simple.
People who use information technology most effectively
will be rewarded.
Artificial intelligence (AI) as an academic discipline began at the
famous 1955 Dartmouth conference organized by John McCarthy from
Stanford [...])

AI,
IA, and the New Research (Hunting Investment Alpha and
Trading Alpha from Online News, Social Media, and Rumors
Alpha hunters are always looking for new territory. When a strategy
becomes known and used by too many players, the collective market
impact of getting in and getting out will squeeze out all the profit
juice, and only the lowest-cost transactors (large sell-side [...])

Stupid Data
Miner Tricks (To Err Is Human. To Really Screw Up, You Need a
Computer.
— Popular Campus T-shirt, circa 1980
Stupid Data Miner Tricks in Quantitative Finance
This chapter started out over 10 years ago as a set of joke slides
showing silly, spurious correlations. Originally, my quantitative
equity research group planned on deliberately abusing the genetic
algorithm (see Chapter [...])

Greatest
Hits of Computation in Finance (Computational Finance, Stock
Market Analysis, and Investment Trading
"A computer does not substitute for judgment any more than a pencil
substitutes for literacy. But writing without a pencil is no particular
advantage." - Robert McNamara
The Journal of Portfolio Management (JPM*) is one of the more upscale
investment management and financial
article publications around. For
$500 a year, you get [...])

An
Illustrated History of Wired Markets (An Illustrated History
of Wired Capital Markets
"Progress might have been all right once, but it has gone on too long."
-- Ogden Nash
This chapter is based on a number of ever-evolving dinner and lunch
talks I have given over many years, all called “Nerds on Wall Street"
irrespective of their actual subject. Many financial conference [...])

A
Gentle Introduction to Computerized Investing (Computerized
Investing, Index Funds, Quantitative Investing, and Active Management
“Life would be so much easier if we only had the source code.” — Hacker
proverb
The beginning of index investing in the 1970s was the result of a
convergence of events, one of those ripe apple moments. Institutional
investors began to use firms like A.G. Becker to actually [...])

Three
Hundred Years of Stock Market Manipulations (300 Years of
Stock Market Manipulations - From the Coffeehouse to the World Wide
Web's Stock Manipulations
In previous chapters, we saw that many of the changes in securities
markets brought about by information technology in general and the
Internet in particular are positive, democratizing access to markets
and information. We also saw that technology is [...])

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